That’s how I’ve always thought of myself: reasonable, but not rational. Reasonable at best, perhaps, but never rational. I weigh and consider, as Bacon put it so well, but I never process. Now Daniel Kahneman has written a book claiming that almost everybody is just like me. He adds, though, that it may be unreasonable not to master a certain degree of statistical competence, for use in making high-stakes decisions.

We will draw a veil across the high-stakes decisions that, in retrospect, I clearly bungled. It’s holiday season, no time for moping.

One of the findings that Kahneman works with is called loss aversion; the simple-minded understanding of this principle that I’ve carried away from my reading of Thinking, Fast and Slow is that it takes $2.0o in gains to offset the pain of $1.00 in losses. The prospect of winning two dollars is as attractive as the prospect of losing a dollar is unattractive. Most of us live sounder lives because of this highly conservative outlook.

Well, no sooner do I finish Kahneman’s book than I pick up Nicholas Dunbar’s The Devil’s Derivatives, the first chapter of which describes a gaggle of bonus-happy bankers as the men who like to win. What this means, we’re told, is that these are (young) men whose aversion to losses is negligible. For them, the appeal of a bet to win $2.00 is so great that it will overpower the dread of losing $2,000,000. I exaggerate, but you get the picture. Dunbar reminds us that bankers used to be extremely loss averse. Their outlook changed, however, when the very nature of risk was recast, starting in the 1990s, in fancy formulas, some of them devised by actual rocket scientists. The bankers didn’t understand the formulas, of course, but they liked the whopping revenues that the more daring young men, such as Peter Merriwether, were piling up. The money was literally intoxicating.

“Intoxicating” is a serious word, like “terrible,” that is often used frivolously. Nowadays, to make sure that the point that I just tried to make gets across, you have to say, “the money was toxic.” But of course that elides the component of thrilling fun that bankers had on the way to the graveyard.  It also misses the point that bankers gave up being reasonable because they thought they were being rational.

 

Drop me a line at rjk@dailyblague.com
This entry was posted on Wednesday, December 21st, 2011 at 10:05 am.